Investors turn defensive

Investors turned defensive yesterday, abandoning investments that had been doing well in the past few years on the back of strong economic growth. Investments that are likely to out-perform in a weak economy, on the other hand, gained.

Commodity prices fell across the board. Gold futures for June delivery fell US$26.80 or 3.8 percent to close at US$685 an ounce, June US light crude futures closed down US$2.63 or 3.7 percent at US$69.41 a barrel while July copper futures fell 11.75 US cents or 3 percent to close at US$3.7465 a pound.

Stocks fell, especially those in emerging markets. Benchmark stock indices fell 6.3 percent in Indonesia, 3.8 percent in India, 3.3 percent in Singapore and 3.0 percent in Argentina. China bucked the trend, the Shanghai market surging 3.8 percent.

However, emerging markets were not the only ones that suffered. Europe was not spared either. In the UK, stocks fell 2.2 percent, German stocks fell 1.0 percent and French stocks 1.7 percent. The Norwegian stock market plunged 5.3 percent.

Investors did not abandon the US market though. Blue chips especially gained, with the Dow Jones Industrial Average rising 0.4 percent and the Standard & Poor's 500 rising 0.3 percent. The Nasdaq Composite, however, fell 0.2 percent and market breadth was generally negative, with declining stocks outnumbering advancers by a ratio of about 4 to 3 on the New York Stock Exchange and close to 2 to 1 on Nasdaq.

The US dollar recovered from recent losses yesterday, especially against the currencies of emerging economies. Indonesia's currency in particular tracked its stock market's losses, the rupiah falling 4.5 percent against the US currency.

US bonds not surprisingly gained, the 10-year Treasury note closing up 11/32 at 99 25/32, with a yield of 5.16 percent, down from 5.19 percent at Friday's close. The spread between the yield on emerging market bonds and Treasuries widened by 12 basis points to 1.96 percentage points, according to the JPMorgan Chase EMBI+ index.

If markets acted as though the global economy is slowing, economic data from the US yesterday gave them some justification. The New York Federal Reserve Bank reported yesterday that its Empire State Manufacturing index fell to 12.4 in May from 15.8 in April, while the National Association of Home Builders reported that the NAHB/Wells Fargo Housing Market index fell to 45 in May -- the lowest level since mid-1995 -- from 51 in April.

Does yesterday's market action signal the end of the bull run in asset and commodity prices? Possibly, but it is obviously too soon to tell. The global economy is widely expected to slow, but markets appear to be driven as much by liquidity as by economic prospects.

In this respect, the major central banks have not shown themselves to be particularly hawkish on interest rates. Last week, the Federal Reserve raised interest rates by 25 basis points but gave little firm indication that it is likely to raise rates further. In the previous week, the European Central Bank left interest rates unchanged. The Bank of England has expressed the view that little interest rate increase is required, even though its housing market appears to be re-accelerating. And just yesterday, Bank of Japan Governor Toshihiko Fukui gave two speeches, neither of which provided any hint of an imminent rate hike.

Benign central bank action means that interest rates are unlikely to spike upwards and asset markets are therefore likely to stay relatively well-supported.

Nevertheless, recent increases in market volatility indicate that investors may be getting nervous, as well they should be in view of the extent and duration of the run-up in markets in this cycle so far. For the more risk-averse investors, a rebalancing of portfolios out of riskier assets into more defensive ones at this point in time appears to be appropriately prudent.